Proof that promised work is fulfilled is vital before Canadian Pacific sells, state says

Aug. 25, 2013

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The Canadian Pacific Railway says it has four or five interested buyers for western section of the old DM&E line that runs through South Dakota. / Argus Leader file photo

TIMELINE

1986: The Dakota, Minnesota & Eastern Railroad is founded from railroad track the Chicago and North Western Railway wanted to abandon. The deal to create DM&E is negotiated by U.S. Sen. Larry Pressler and his chief of staff, Kevin Schieffer. The initial network runs from Winona, Minn., to Rapid City over 825 miles. May 1996: DM&E buys a 200-mile rail line running from Crawford, Neb., through Rapid City to Colony, Wyo., from Union Pacific. November 1996: Schieffer becomes president of the DM&E after previously serving as its legal counsel. February 1998: The DM&E applies for approval to build an expansion into Wyoming’s Powder River Basin coal mining region. July 2002: The railroad more than doubles in size with its purchase of the Iowa, Chicago & Eastern railroad, with access to Chicago, Kansas City, Mo., and Minneapolis as well as farms and towns in Iowa, Illinois and Missouri. February 2006: The federal Surface Transportation Board gives DM&E final approval to pursue the Powder River Basin project after years of challenges and delays February 2007: The Federal Railroad Administration denies the DM&E a $2.3 billion government loan it requested to help pay for the Powder River Basin project. Schieffer begins looking for private sector money to help pay for the expansion. September 2007: The Canadian Pacific Railway announces it will buy the DM&E for $1.48 billion. Under the terms of the deal, Canadian Pacific will pay more than $1 billion more if it pursues the Powder River Basin project. October 2008: After final approval from the Surface Transportation Board, Canadian Pacific takes over DM&E. Schieffer resigns as president. December 2012: The Canadian Pacific announces it will abandon the Powder River Basin project for good. The next day, it puts the western part of the DM&E line, including all its track in South Dakota, up for sale. August 2013: Gov. Dennis Daugaard petitions the Surface Transportation Board to make the Canadian Pacific prove it made promised investments before it can sell its South Dakota railroads.

DM&E tracks are seen in Huron in 2005. The Canadian Pacific wants to sell 575 miles of line that runs through South Dakota. / Argus Leader file photo

Kevin Schieffer

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It would be like taking the interstates out of South Dakota.

That’s how farmers and factory owners see the railroads — the main line of travel bringing their goods to market. Many of them are watching closely as the Canadian Pacific Railway tries to sell part of the Dakota, Minnesota and Eastern Railroad. The state is watching as well, examining promises the company made when it bought the DM&E in 2008.

Prospects seemed bright then.

The international railroad giant promised to rebuild the aging track across South Dakota, give shippers access to world markets — and possibly turn the state into an energy corridor, shipping coal east from Wyoming.

But then the world economy collapsed.

Coal power started to fall out of favor, and booming natural gas production drove down demand for Wyoming’s Powder River Basin fuel.

And the Canadian Pacific changed its focus. Now, the railroad is looking for a buyer for the track west of Tracy, Minn. — including almost 575 miles of track running the length of South Dakota.

The Powder River Basin dream that former DM&E president Kevin Schieffer sold across the Upper Midwest — battling opposition from township boards to the Mayo Clinic — is all but dead.

That project — shipping coal across South Dakota — was one of the main reasons Schieffer looked to team with the Canadian Pacific. Two railroads already shipped low-sulfur coal out of northeastern Wyoming, but demand seemed high enough to support a third with direct access to eastern markets.

“There’s places out there where they’re loading three trains simultaneously to save money,” said Robert Warrick, a railway consultant, of the Powder River Basin coal fields.

That coal would bring with it money — money to pay for, and justify, rebuilding the dilapidated track in western South Dakota.

But almost as soon as the deal was sealed to sell the DM&E, the Powder River Basin promise started to fade.

“The then-CEO I think surprised his own staff by emphasizing they were going to take a slower approach to the PRB project,” Schieffer said. “CP was the most enthusiastic about (the Powder River Basin) among the numerous (DM&E) suitors. Literally starting with the day it was announced, CP sort of had a different emphasis or a different shift in priorities.”

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And now, as the Canadian Pacific looks to sell and the state questions whether the railroad followed through on its investments, farmers such as Reno Brueggeman worry about the future.

“If you take this line away from central South Dakota, it would be like taking I-90 out of South Dakota,” said Brueggeman, who farms north of Miller.

Tim Luken, general manager at Oahe Grain Corp., agrees. “There’s just a basket full of problems we could have,” he said.

South Dakota has no official role in the sale and regulation of the Canadian Pacific, as a railroad that crosses state lines. That oversight is handled by the federal Surface Transportation Board. Instead, the state’s role is as an advocate, filing petitions asking the federal board to take action.

Canadian Pacific shifting focus to greater efficiency

The DM&E isn’t the only major railroad running through South Dakota. In addition to a number of short-line railroads, international giant BNSF owns almost 900 miles of track in the state. One of its lines runs from the southeastern part of the state through Sioux Falls to Aberdeen. The other heads east-west across the northern part of South Dakota, passing through Aberdeen on its way to North Dakota and the Pacific Northwest.

Buying the DM&E brought Canadian Pacific more than just the option to build a railroad to Wyoming coal mines — it gave the company an efficient regional railroad with access to Midwestern markets, farms and ethanol plants, no matter what happened with the Powder River Basin.

“Those assets are very valuable,” CEO Fred Green said in April 2012. “The DM&E (earnings) will double between 2006 and 2012, ahead of the pace that we said it would happen. So we’re delighted with that.”

But a month later, Green was gone. A New York investor, upset about the Canadian Pacific’s inefficiencies, put in place a new board of directors for the company and replaced Green with Hunter Harrison, an executive with a reputation for cutting costs.

Last December, Harrison announced he was putting the DM&E line west of Tracy, Minn., up for sale — including the company’s entire South Dakota holdings.

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The DM&E merger “has not played out like some would have liked,” Harrison told investors.

“The new management there, under the reins of Hunter Harrison, is taking a look at what they own and seeing what fits and what doesn’t,” said Jason Seidl, a managing director at Cowen and Co. who specializes in analyzing railroads. “They’re trying to slim down the property a bit.”

Stock in the Canadian Pacific jumped to a 10-year high the day Harrison announced the potential sale. A sale could happen by the end of the year, said the company’s chief financial officer, Brian Grassby.

Questioning the progress of upgrades to the lines

When the Canadian Pacific was trying to buy the DM&E, it promised to make a big investment upgrading the line.

The company said it would invest $300 million improving the DM&E line in South Dakota and Minnesota.

But it’s unclear exactly how much money the Canadian Pacific actually invested in the DM&E track, five years after the deal went down.

When the state of South Dakota asked, the Canadian Pacific said it had spent $316 million on Canadian Pacific facilities from 2008 to last year. But it didn’t provide detailed data to back up the claim, leaving state officials skeptical.

“The governor and other members of his administration ... started talking to the railroad officials last December, asking a lot of these same questions, and so far have not really received an answer,” said Tony Venhuizen, a senior adviser to Daugaard. “You have to think if they had made all these improvements and could demonstrate that, they’d have been pretty quick to do that.”

Clearly, some improvements have been made. Maps released by the company show large stretches of track east of Huron have been upgraded to the Class 3 standard, which allows freight trains to go up to 40 mph.

“We’re aware that DM&E has done some upgrading of their track, particularly in the Rochester area,” said Tim Spencer, manager of rail planning with the Minnesota Department of Transportation.

But Minnesota and South Dakota lack records showing exactly how much. Also uncertain is the Federal Rail Administration, which was tasked with monitoring the Canadian Pacific after the DM&E merger.

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Petition to force answer

So this month, Daugaard filed a petition with the federal Surface Transportation Board, which regulates rail lines, seeking to force Canadian Pacific to say how much it’s spent on upgrades to the DM&E system.

If those upgrades haven’t been made at the level promised, then Daugaard asked the Surface Transportation Board to prevent Canadian Pacific from selling its DM&E track until it keeps that commitment.

Canadian Pacific officials contend they have met their obligations, spokesman Ed Greenberg said. Whatever promises were made in 2008 might need to be revised because of changing circumstances, a top executive wrote in a letter to the state.

“The commitments made by CP in 2007 were made by different corporate management,” wrote Douglas McFarlane, then the Canadian Pacific’s senior vice president for U.S. operations. “I would add that they were also made shortly before the American economy, and indeed the world economy, plunged into the worst recession since the Great Depression. CP was forced to let go or lay off thousands of employees.”

State of the track

Those upgrades the state and railroad are battling over are most urgently needed West River. The track east of Pierre in South Dakota and Minnesota is relatively new, rebuilt by DM&E before the merger from 2002 to 2005, Schieffer said.

But from Fort Pierre west to Wall, and then again from Hermosa south to the Nebraska border, tracks are older, and in worse condition.

“There are some unique issues between Pierre and Rapid City dealing with both subsoil and the number of bridges,” Schieffer said.

Some of that track is rated Class 1 by the federal government, meaning trains can’t exceed 10 mph. Much of the rest doesn’t even meet that standard — it’s operating under an exception from Federal Rail Administration rules. That means both passenger trains and freight trains with more than five cars of hazardous material are banned from the track for safety reasons.

“You have to operate it at much slower speeds. It’s much less efficient. You’ve got to undertake additional safety precautions to be able to operate on it,” Schieffer said. “You can operate it, but there’s a lot of challenges with it. And you’re not supposed to do that on a permanent basis.”

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The western track also wasn’t upgraded to carry heavier rail cars that now are standard in the rail industry. That means newer cars can run there only if partially full. More often, the newer cars don’t get sent there at all, said Jerry Cope, an executive with Dakota Mill and Grain, which operates multiple grain elevators along the track in western South Dakota.

“The railroads ... will take those newer cars elsewhere because they can fully utilize them, and we get the smaller (and older) cars,” Cope said. “Like anything, as it gets older, you’re going to have more cars that you can’t load because you can’t seal them tight enough.”

Before the merger, the DM&E’s plan was to not even bother making repairs to the western track.

“We were just going to build a new railroad right beside it, which would be in the long run better and cheaper,” Schieffer said.

Cheaper didn’t mean cheap, though. Schieffer said he couldn’t recall the exact figures, but one rule of thumb is that it costs at least $1 million to build a mile of new railroad. Under that formula, the cost of rebuilding the western part of the market is more than $100 million.

That kind of expense makes sense only if the railroad is going to see enough use to win back the investment.

“I’ve done studies (on) the costs of raising track class, what it would really get you back,” Warrick said. “If the payoff is 15 or 20 years, you’ve not going to bother.”

That’s part of why Schieffer pursued the Powder River Basin project. Coal trains could provide the traffic, and income, to justify upgrading the line in a way that the current shipments of grain, cement and bentonite don’t, Schieffer said.

Watching carefully

South Dakota shippers now are watching to see the outcome of Daugaard’s petition to the Surface Transportation Board. Their hope is, whatever Canadian Pacific ends up doing with the DM&E railroad, it spends the money it said it would in 2008.

“I would just like to make sure those improvements have been done, or whoever’s going to buy this line (does so) under the understanding that these improvements do need to be made to keep this line viable,” Brueggeman said.

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The Canadian Pacific has until Wednesday to file a response to South Dakota’s petition, and will do so, Greenberg said.

“It will show our railroad has appropriately addressed each of the concerns raised by the state’s petition and that we have met our obligations,” he said.

The Surface Transportation Board has yet to issue a ruling. When it does, it might not be what Daugaard wants.

“I would not be surprised if Canadian Pacific were not meeting their requirements, and I would not be surprised if the Surface Transportation Board did nothing about it,” said former U.S. Sen. Larry Pressler, who helped create the DM&E in the 1980s and was chairman of the Senate Commerce, Science and Transportation Committee. “The national railroads are just completely in bed ... with both political parties.”

In fact, the DM&E’s own birth involved a heavy role of politics — from Pressler himself. As U.S. senator, he stepped in when another railroad wanted to abandon its South Dakota track and instead negotiated the creation of the DM&E.

Integral in that process was Pressler’s chief of staff at the time — Schieffer.

As the process plays out, shippers will be keeping a close eye on who, if anyone, ends up buying or leasing DM&E line west of Tracy. The identity of that buyer, several said, will have a mighty influence on their future.

Whether that buyer ends up being an improvement on the Canadian Pacific or a step back, some observers are becoming nostalgic for what they had with the DM&E before the sale.

“When they proposed to buy the DM&E, we had service to St. Paul and Minneapolis. We had service to Chicago. We had service to Wisconsin. We had service to Kansas City,” said Matt Konenkamp, Daugaard’s adviser on transportation issues.

“Had we known that in a few short years they would turn around and sell this and leave us with access only to Tracy, Minn., I think people would have taken a different look at their proposal.”